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Become the Beneficiary of your own Financial Insurance Policy by having an EMERGENCY FUND1/19/2016
The financial services industry tells households to have an emergency fund. Seldom if ever do they tell you why, or how much you need and where to save. Too often they use the same old rule of thumb. Rules that are many years old and may, or may not work. There is a much easier and better way for people to set their emergency fund goal with confidence, one that does make sense.
Most often, nine times out of ten the emergency fund is needed and used for loss of income, not loss of expenses. It makes perfect, logical sense to use income as the goal for an emergency fund, and hereís why. The emergency fund is replacing a loss of income in most cases, simple really. You donít lose expenses so why base an emergency fund on your expenses. Most households have no idea what their real monthly household expenses are, but most can tell you what their monthly gross income is. Even if they did know their monthly expenses, using a moving target to set a goal is illogical and is missing an opportunity to make this easy.
The emergency fund is only used for emergencies. The engine in your car blows-up, transmission fails, you need to move unexpected in short notice, and loss of a job or income; otherwise donít touch the emergency money. It takes maturity and discipline to have an emergency fund.
Itís recommended to use a balanced approach to build an emergency fund. Using a seven year term as a goal is a good balanced approach. This makes the monthly savings goal achievable by implementing a balanced plan. A proper emergency fund goal is six months gross income. This is easy to remember, so use this as a goal. Self-employed should set a larger goal, preferably 12 months income but set this as a ten year goal. If your household income fluctuates add your last three months of household income and divide the total by three to give you a good ball-park number to use.
Setting an Emergency Fund monthly savings amount.
Example: Monthly household gross income is $3,500 X 6 months = $21,000 then divide by 7 years (84) giving a goal to save $250 per month on average for the year. Some months you can save more, others less. Once you hit your goal donít stop saving.
An emergency fund is not a 401 k or retirement account. Credit cards are not for emergencies, or loans. Become your own bank by using cash for an emergency fund, borrow from yourself for emergencies. Many say save it in a Money Market account. There may be better options than a money market account, with lower fees and higher interest. There are plenty of FDIC high interest savings accounts paying over 1% interest with 0 fees, 0 minimums and you can open with a few dollars with free access and free transfers. These higher interest savings accounts have been around for many years.
Make sure you are saving into your emergency fund first then your retirement second. You may need to use an emergency savings 10 to 20 times in your life before you ever need your retirement accounts. With a proper emergency fund you may be able to save your household from a bankruptcy, or dealing with debt collectors if you have an extended income interruption. Being able to cover expenses for an extended period of time while you recover from a financial emergency is priceless.
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